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61ST  CONGRESS  :  :  2d  SESSION 

1909-1910 


SENATE  DOCUMENTS 


Vol,  40 


WASHINGTON  :  :  GOVERNMENT  PRINTING  OFFICE  :  :  1911 


61sT  Congress  \  ctttsjat't?  /Document 

2d  Session       ]  SENATE  |     No.  589 


NATIONAL  MONETARY  COMMISSION 


Bank  Loans 

and 

Stock  Exchange  Speculation 


BY 


JACOB  H.  HOLLANDER 

Professor  of  Political  Economy  it  the  Johns  Hopkins  Unrversiry 


m 


^r 


WASHINGTON 
1911 

i  1 1)  9  S 


NATIONAL  MONETARY  COMMISSION. 


Nelson  W.  Aldrich,  Rhode  Island,  Chairman. 
Edward  B.  Vreeland,  New  York,  \' ice-Chairman. 


Julius  C.  Burrows,  Michigan. 
Eugene  Hale,  Maine. 
Philander  C.  Knox,  Pennsylvania 
Theodore  E.  Burton,  Ohio. 
Henry  M.  Teller,  Colorado. 
Hernando  D.  Money,  Mississippi. 
Joseph  W.  Bailey,  Texas. 

A.  Piatt  Asdr^w,  Special  .\ssista71t  to  Commission 


John  W.  Weeks,  Massachusetts. 
Robert  W.  Bonynge,  Colorado. 
Lemuel  P.  Padgett,  Tennessee. 
George  F.  Burgess,  Texas. 
Arsicne  p.  Pujo,  Louisiana. 
Arthur  B.  Shelton,  Secretary. 


IZI3 
1^5  HI 


BANK   LOANS   AND   STOCK   EXCHANGE 
SPECULATION. 


Attention  has  been  repeatedly  called  to  the  vicious 
circle  in  which  the  American  money  market  moves;  how 
the  volume  of  banking  credit  is  rigidly  inelastic,  being 
determined  as  to  circulation  by  bond  security  and  as  to 
loans  and  discounts  by  a  fixed  ratio  to  legal  reserve; 
how  the  surplus  funds  which  pile  up  with  seasonal  fluc- 
tuation in  the  interior  flow  inevitably  to  New  York  City, 
there  to  stimulate  speculation  at  times  when  general 
economic  conditions  suggest  quiescence,  and  how,  con- 
versely, when  returning  activity  draws  back  fimds  to  the 
interior,  the  recovery  is  impeded  by  the  strain  and  cost 
of  speculative  liquidation. 

This  sequence,  as  often  as  it  has  been  stated,  has  not 
been  really  accepted  by  the  public  mind.  There  has  been 
much  more  disposition  to  invert  the  relation  and  to  hold 
speculative  manipulation  responsible  for  monetary  strain. 
To  the  extent  that  blind  prejudice  and  willful  ignorance 
figure  here,  nothing  in  the  way  of  enlightenment  is  pos- 
sible. But  some  considerable  part  of  the  prevailing  senti- 
ment is  not  to  be  so  dismissed  and  proceeds  from  valid 
doubt.  It  is  this  condition  which  invites  an  attempt  to 
supplement  the  general  terms  in  which  the  argument  has 
heretofore  been  phrased  with  a  more  detailed  account  of 
the  relation  of  credit  and  speculation. 


National    Monetary     Commission 

In  the  United  States  the  money  market,  in  the  form  of 
bank  loans,  may  be  regarded  as  impinging  upon  the  stock 
exchange  at  five  distinct  points : 

(i)  Stock-exchange  securities  are  used  as  collateral  to 
secure  mercantile  discounts  and  personal  loans  in  the 
insufficiency  of  commercial  or  personal  credit. 

(2)  In  the  interval  between  original  sale  and  ultimate 
absorption  by  im/estors  newly  issued  corporate  securi- 
ties are  used  by  underwriting  syndicates  and  syndicate 
participants  to  secure  bank  advances. 

(3)  Banking  institutions  invest  in  stock-exchange  secu- 
rities such  part  of  their  resources  as  are  not  employed  in 
loans  and  discounts  in  consideration  of  interest  return 
and  in  anticipation,  semispeculatively,  of  appreciation  in 
market  value. 

(4)  Bond  houses  and  stock  brokers  engaged  in  the  sale 
of  investment  securities  obtain  bank  loans  as  working 
capital  upon  unsold  holdings.     •  'iM.-x^ 

(5)  Speculative  purchases  of  stock- exchange  securities 
are  financed  partly  by  time  loans,  but  in  the  main  by 
demand  loans  obtained  from  banking  institutions  and 
secured  by  such  securities  as  collateral. 

It  is  proposed  to  consider  the  nature  and  effect  of  each 
of  such  contacts  from  the  standpoint  of  present  banking 
organization  and  of  proposed  change.  Such  an  inquiry 
is  impeded  by  the  paucity  of  statistical  data  and  by  the 
intimate  or  informal  quality  of  many  of  the  operations 
involved.  But  enough  is  ascertainable  to  permit  a  fair 
and  reasonable  judgment  as  to  the  adequacy  of  existing 
methods  and  as  to  the  effect  of  possible  amendments. 


Bank  Loans  and  Stock  Exchange  Speculation 

I. 

The  occasion  for  temporary  advances  of  credit  upon 
adequate  collateral  is  directly  connected  with  the  dawn 
of  modern  banking.  Commercial  activity  is  subject  to 
varying  capital  requirements.  Unless  business  opera- 
tions are  to  be  restricted  within  imnecessarily  narrow 
limits  or  a  wastefully  idle  reserve  fund  is  to  be  kept  at  all 
times  available,  that  quota  of  capital  for  which  there  is 
brief  or  exceptional  business  demand  will  find  productive 
employment  in  independent  investment.  The  same  is 
true  of  individual  economics.  Private  capital  is  converted, 
as  accumulated,  into  productive  investment — less  only 
that  part  required  for  current  requirements. 

Such  an  economical  arrangement  is  obviously  possible 
only  when  the  machinery  exists  for  securing  credit 
advances  upon  investment  reserves  at  the  time  and  "for 
the  period  required.  This  is  the  service  of  the  banking 
organization.  Reserve  investments  take  on  many  forms — 
bank  deposits,  real  estate,  staple  commodities,  evidences 
of  indebtedness.  The  widespread  extent  of  corporate 
organization  and  the  readiness  of  international  markets 
for  corporate  obligations,  might  be  expected  to  make 
stocks  and  bonds,  and,  in  particular,  those  more  actively 
traded  in  and  distinguished  as  stock  exchange  securities — 
a  convenient  object  of  such  investment  and  a  common 
collateral  for  business  loans. 

But  as  a  matter  of  fact,  credit  advances  upon  stock 
exchange  collateral  play  a  relatively  small  part  in  American 
business  life,  meaning  by  this  term  ordinary  industrial, 
commercial,  and  mercantile  activity  as  distinct  from  cor- 
porate promotion  and  speculative  enterprise.     The  aver- 


National    Monetary     Commission 

age  merchant  or  manufacturer  keeps  his  reserve  in  his  bank 
book  not  in  his  safe-deposit  box,  and  seeks  to  meet  the 
strain  of  sudden  or  increased  financial  requirement  by- 
further  recourse  to  commercial  loans  and  discounts.  If 
he  owns  stock-exchange  securities,  his  impulse  will  be  to 
sell  them  when  the  occasion  arises  rather  than  to  borrow 
upon  them,  and  if,  because  of  unfavorable  markets  or 
other  considerations,  he  hesitates  at  accepting  this  loss, 
his  banker  is  likely  to  be  less  reluctant.  Any  pressure  to 
secure  further  advances  upon  such  collateral  may  threaten 
his  existing  credit  and  result  in  the  diversion  of  the  securi- 
ties to  fortifying  earlier  loans  rather  than  securing  new 
ones.  Anticipating  such  procedure  the  business  man 
who  owns  securities  and  wishes  to  borrow  upon  them 
inclines  to  hypothecate  them  with  a  different  financial 
institution  rather  than  to  seek  further  accommodation 
from  his  usual  bank,  unless  indeed  the  occasion  for  the 
accommodation  sought  be  personal  rather  than  commer- 
cial, in  which  event  a  more  cordial  banking  attitude  may 
be  anticipated. 

In  so  far,  therefore,  as  stock-exchange  securities  serve 
as  business  collateral  they  represent  in  the  main:  (a)  In- 
dividual loans  by  those  who  are  without  commercial  or 
personal  credit  or  who  are  unwilling  to  use  it  even  though 
they  possess  it ;  (6)  supplementary  business  loans  by  those 
who  have  exhausted  the  maximum  commercial  credit 
which  their  customary  banks  have  found  it  possible  to 
accord,  and  (c)  loans  made  by  corporations  who  have 
been  unwilling  or  unable  to  market  their  own  obligations 
and  are  driven  to  use  these  in  part  to  secure  urgently 
needed  borrowings. 


Bank  Loar.s  and  Stock  Exchange  Speculation 

No  question  has  ever  been  raised  as  to  the  utility  of 
this  feature  of  our  banking  system.  It  is  obviously 
advantageous  that  those  engaged  in  business  activity, 
or  individual  effort,  who  happen  to  be  owners  of  stocks  or 
bonds,  should  be  able  upon  proper  occasion  to  secure 
temporary  advances  of  credit  thereon  without  the  waste 
and  friction  of  forced  sale.  The  banks  here  simply  serve 
as  pawnshops  for  securities.  Capital  is  made  more  mobile 
without  sacrifice  of  productivity,  and  both  the  business 
community  and  the  investing  public  are  benefited. 

In  all  this  speculative  activity  plays  no  part.  There  is 
some  complaint  that  commercial  banks  are  disposed  to 
discriminate,  either  as  to  percentage  of  collateral  or  as 
to  general  acceptability  in  favor  of  particular  securities  to 
the  detriment  of  others  of  equal  intrinsic  worth  but  of 
less  marketability;  but  this  is  either  prudence  or  ultra- 
conservatism,  as  the  case  may  be,  reflecting  the  personal 
equation  of  the  bank  directorate  or  the  business  temper  of 
the  particular  community.  In  the  case  of  "controlled" 
institutions  tliis  discrimination  is  commonh"  charged  to 
be  inspired  by  less  justifiable  considerations,  and  recent 
exposures  have  shown  some  startling  instances  in  point. 
But  for  this  as  for  the  related  practice  of  imprudent  cor- 
porate loans  secured  by  the  borrowing  corporation's  own 
securities,  or,  indeed,  for  any  other  fonn  of  reckless  com- 
mercial discounting,  there  is  no  other  safeguard  than  rigid 
supervision  and  relentless  accountability.  Such  unwhole- 
some conditions  might  exist  utterly  irrespective  of  specu- 
lative activities,  and,  indeed,  find  their  exact  counterpart 
in  small  one-bank  localities  completely  removed  from 
monopolistic  influences. 

14119'^ — II 2  7 


National    Monetary     Co  remission 

But  in  another  direction  the  use,  however  limited,  of 
stock-exchange  securities  as  business  collateral  brings  us 
face  to  face  with  a  signal  defect  of  the  American  banking 
system — the  hard  and  fast  limit  set  upon  the  credit  facili- 
ties of  business  enterprise. 

'  The  business  man  in  the  United  States — merchant, 
manufacturer,  or  trader — secures  his  banking  accommo- 
dations upon  the  strength  of  personal  credit;  that  is,  by 
the  discount  of  indorsed  commercial  paper  or  of  his  own 
promissory  note,  if  necessary,  fortified  by  further  indorse- 
ment. The  amount  which  he  can  so  borrow  is  not,  as 
might  be  expected,  the  discounted  present  value  of  pros- 
pective payments  based  upon  actual  mercantile  deliveries, 
but  a  definite  maximum  calculated  as  a  multiple  of  his 
average  bank  balance  and  fixed  by  the  bank  executives 
with  respect  to  the  estimated  resources  and  requirements 
of  the  borrower  in  relation  to  similar  demands  and  re- 
sources of  the  bank's  other  customers.  It  takes  the  form 
of  discounted  notes  of  stated  maturity  and  varies  from 
month  to  month  with  business  requirements,  largely  at 
the  borrower's  option.  The  bank  is  virtually  obliged, 
save  at  the  risk  of  exciting  resentment,  to  grant  and 
renew  such  loans  if  within  the  maximum;  on  the  other 
hand,  the  ordinary  borrower  must  not  expect,  save  under 
circumstances  of  unusual  stress,  increased  credit  facilities 
beyond  the  maximum  informally  agreed  upon. 

If  the  maximum  line  of  credit  which  a  single  banking 
institution  can  grant  be  normally  insufficient,  either  by 
reason  of  its  own  limited  resources  relative  to  aggregated 
patrons'  demands  or  by  reason  of  the  positive  loan  limita- 
tions of  the  national-bank  act,  the  ordinary  business  man 


Bank  Loans  and  Stock  Exchange  Speculation 

will  have  established  analogous  relations  with  one  or  more 
other  banking  institutions;  but  in  each  of  these  an  iden- 
tical policy  will  prevail.  The  borrower  will  be  accorded  a 
maximum  line  of  credit,  all  of  which  he  can  upon  occasion 
properly  demand,  but  beyond  which  he  can  not  hope  to  be 
accommodated . 

We  have  here  a  mischief-making  failure  of  the  American 
banking  system  to  respond  to  legitimate  business  require- 
ments. It  is  not  speculation  but  production  that  is  halted 
and  ultimately  stopped  by  the  rigidity  of  our  obsolete 
credit  mechanism.  The  experience  of  every  other  great 
industrial  country  of  the  world  makes  clear  that  an  un- 
limited discount,  though  at  rising  cost,  of  valid  commer- 
cial bills,  a  credit  fabric  based  upon  and  varying  with  the 
volume  of  commercial  paper,  a  mobilized  gold  reserve,  and 
an  open  discount  market  are,  from  the  standpoint  of  the 
producers  of  wealth,  indispensable  requisites  of  sound 
mercantile  banking. 

II. 

In  the  United  States,  as  in  the  other  great  industrial 
countries  of  the  world,  the  intervention  of  banking  insti- 
tutions has  become  an  indispensable  element  in  corpora- 
tion financiering.  The  capital  requirements  of  industrial 
enterprise  can  only  be  ultimately  satisfied  by  the  response 
of  the  investing  public.  That  is  to  say,  those  who  have 
accumulated  capital  by  saving  or  transfer  become  creditors 
of  or  participants  in  such  enterprise.  AVhen  the  under- 
taking is  organized  in  corporate  form  this  involves  the 
issue  and  sale  of  certificates  of  ownersliip  or  evidences  of 
indebtedness,  stocks  or  bonds. 


National    Monetary     Commission 

In  the  early  days  of  corporate  financiering,  both  public 
and  private,  the  method  of  open  popular  subscription  at 
fixed  terms  was  employed,  the  list  being  exposed  at  desig- 
nated places,  and  the  general  public  invited  to  respond. 
But  with  the  tremendous  increase  in  public  and  corporate 
borrowing  and  the  wide  fluctuations  in  market  credit,  the 
method  of  public  subscription  was  gradually  abandoned 
for  a  more  certain  procedure.  The  transition  is  probably 
to  be  associated  with  Pitt's  bold  financial  policy  in  Eng- 
land's contest  with  Napoleon.  In  the  early  days  of  the 
British  funding  system  subscription  lists  to  public  loans 
were  posted  at  the  Exchequer  and  after  1 7 1 4  at  the  Bank 
of  England.  But  Pitt's  financial  necessities  could  brook 
neither  delay  nor  uncertainty,  and  in  the  war  the  great 
Chancellor  of  the  Exchequer  developed  the  prototype  of 
modern  underwriting  syndicates — a  company  of  "loan 
contractors,"  with  whose  rise,  indeed,  the  beginnings  of 
England  as  the  capital  center  of  the  world  are  directly 
associated. 

Modern  corporate  financiering  makes  use  in  the  main 
of  the  loan-contracting  method,  ordinarily  in  association 
with  underwriting  guaranty.  The  older  open-subscription 
practice  survives  in  occasional  examples,  such  as  the  issue 
of  additional  corporate  obligations  by  the  grant  of  sub- 
scription "rights"  to  existing  security  holders,  the  direct 
offering  of  corporate  emissions  to  general  subscription,  and 
the  flotation  of  public  loans  by  sale  "over  the  counter." 

The  ordinary  procedure  is  for  the  borrowing  corpora- 
tion to  enter  into  an  engagement  with  a  banking  insti- 
tution, public  or  private,  for  the  guaranteed  flotation, 
commonly  at  a  stipulated  price,  of  the  proposed  issue. 


Bank  Loans  and  Stock  Exchange  Speculation 

To  make  effective  this  guaranty  or  underwriting,  or  to 
distribute  its  risk,  the  institution  in  question  will  gen- 
erally have  associated  with  itself  other  institutions  and 
individuals  as  a  syndicate  to  share  in  designated  per- 
centages the  underwriting  obligation  ^v•ith  its  resultant 
gains  or  losses.  Thereafter  subscriptions  to  the  issue  will 
be  invited  by  public  tender,  ordinarily  by  the  contracting 
institution  acting  as  syndicate  manager.  It  is  an  un- 
written law  that  every  participant  in  the  underwriting 
syndicate  shall  assist  in  the  absorption  of  the  loan  by 
sales  through  its  distributing  agencies  or  by  purchase  on 
independent  account.  Any  residue  not  taken  will  ulti- 
mately be  charged  to  the  syndicate  members  in  proportion 
to  respective  participation. 

With  the  great  increase  in  resources  and  the  wider 
range  of  connection  the  great  banking  institutions  of 
the  country,  and  in  particular  a  powerful  group  of  inter- 
national banking  houses,  have  tended  to  eliminate  the  '  v^ 
syndicate  feature  of  underwriting  and  to  become  their 
own  guarantors  by  directly  engaging  to  purchase  the  issue  j 
at  contract  terms.  In  the  interval,  however,  between 
the  preliminary  engagement  and  the  consummated 
arrangement,  the  purchasing  institution  will  have  secured 
from  other  institutions  or  individuals — "allotted"  is 
the  term  more  in  consonance  with  actual  practice — sub- 
scriptions to  participate  in  the  purchase  covering  all 
but  such  part  as  it  may  itself  desire  to  retain.  Such 
subscriptions  will  have  been  made  to  some  extent  by  sav- 
ings banks,  insurance  companies,  and  trustees  for  direct 
investment  purposes,  but  in  the  main  by  junior  banking 
and  brokerage  houses  to  meet  customers'   demands,   in 


National    Monetary     Commission 

consideration  of  a  brokerage  arrangement  and  in  antic- 
ipation of  an  early  rise  in  the  market  price  over  the 
issue  price. 

Whether  the  transaction  involve  a  syndicate  under- 
writing or  not,  the  banking  outcome  is  the  same  in  that  the 
new  securities  will  ultimately  pass  into  the  possession  of 
purchasers  or  participants.  If  times  be  favorable  and  the 
securities  popular  the  issue  is  likely  to  be  absorbed  by  the 
public  in  response  to  the  advertised  offering  made  by  the 
contracting  house  or  the  syndicate  manager  if  for  no  other 
reason  than  to  accredit  the  issue  and  reenforced  by  the 
elaborate  selling  organization  that  the  ordinary  bond 
house  has  developed.  In  such  event,  prompt  absorption 
of  the  issue  by  actual  investors,  there  will  be  no  occasion 
for  banking  intervention.  The  funds  requisite  will  be 
withdrawn  from  individual  savings  accounts  and  bank 
deposits  and  the  purchased  securities  will  find  their  way 
into  strong  boxes. 

If,  however,  general  economic  conditions  are  unfavor- 
able, either  the  trade  purchasers  or  the  underwriting  par- 
ticipants, or  both,  will  find  themselves  with  unsold  blocks 
of  securities  on  hand.  These  may  be  taken  up  at  once  by 
those  ultimately  responsible,  or,  more  likely,  the  unsold 
quota  will  remain  under  the  control  of  the  manager  until 
with  the  expiration  of  an  agreed  or  reasonable  time — often 
extended  and  reextended — the  distribution  of  the  unsold 
remainder  among  the  subscribers  is  consummated. 

Under  such  circumstances  prompt  recourse  will  be  had 
to  banking  institutions  for  advances  of  credit  upon  the 
imsold  or  undistributed  securities.  The  business  of  selling 
investment  securities  is  organized  on  essentially  the  same 


Bank  Loans  and  Stock  Exchange  Speculation 

basis  as  any  other  form  of  merchandising.  The  agencies 
who  acquire  secm'ities  from  the  producer,  in  this  case  the 
issuing  corporation,  do  so  in  the  expectation  not  of  keep- 
ing but  of  selling  them.  Their  own  resources  represent 
working  capital  pure  and  simple,  no  appreciable  part  of 
which  is  expected  to  find  fixed  investment  in  the  securities 
so  bought.  The  profit  of  the  transaction  will  therefore  be 
very  materially  affected  by  the  quickness  of  the  turnover, 
or  the  rapidity  with  which  the  capital  employed  becomes 
reavailable. 

The  stage  at  which  recourse  is  had  to  the  banks  and  the 
extent  to  which  credit  advances  are  sought  varies  with 
the  nature  of  the  contract,  the  resources  of  the  pur- 
chasing house,  and  the  progress  of  the  distribution.  If  the 
issuing  corporation  requires  early  payment,  the  obliga- 
tions in  temporary  form,  or  even  the  purchase  option,  may 
be  used  by  the  purchaser  as  collateral  for  a  bank  loan. 
If  the  loan  be  undersubscribed ,  the  part  left  over  will 
be  similarly  hypothecated;  or  if  the  subscription  be  full 
but  the  absorption  incomplete,  the  undigested  parts, 
either  in  the  custody  of  the  syndicate  manager  or  distrib- 
uted among  the  separate  participants,  will  be  used  as  bank- 
ing collateral.  Ordinarily  such  advances  are  made  by  the 
banks  at  the  rates  prevailing  for  call  money,  or  upon  even 
more  favorable  terms  in  the  case  of  tmderwriting  syndi- 
cates having  strong  banking  connection. 

If  corporate  enterprise  is  to  secure  with  economy  the 
additional  capital  necessary  from  time  to  time  for  gro^vth 
and  expansion,  if  accumulated  savings  are  to  find  pro- 
ductive employment  with  promptness  and  certainty, 
some  such  relationship  between  corporate  borrowing  and 

13 


\ 


National    Monetary     Commission 

banking  accommodation  must  necessarily  exist.  Prac- 
tical experience  in  public  and  private  financiering  has 
made  clear  that,  save  in  exceptional  circumstances,  direct 
sale  in  the  form  of  public  subscription  is  attended  with 
imcertainty  and  risk.  To  be  successful  the  corporation 
must  require  its  money  at  the  very  moment  that  the  saving 
public  has  reached  the  psychological  state  of  investment, 
and  such  coincidence  is  necessarily  unusual. 

An  intermediary  is  obviously  desirable  to  bridge  the 
interval,  to  supply  the  corporation  with  funds  at  the  time 
needed  and  to  make  delivery  to  the  investor  at  the  time 
desired — precisely  as  the  tradesman  serves  as  an  econom- 
ically necessary  middleman  between  producer  and  con- 
sumer. This  is  the  function  of  the  underwriter  or  loan 
contractor.  Like  the  successful  merchant,  he  seeks  to 
reduce  the  interval  between  purchase  and  sale.  He  will 
be  reluctant  to  enter  into  an  engagement  to  take  over  a 
loan  at  a  time  when  he  deems  the  investment  demand 
inadequate  or  sluggish.  And,  on  the  other  hand,  he  will 
be  keen  to  anticipate  returning  confidence,  by  offering 
tempting  investments  before  his  competitors  have  em- 
braced the  opportunity  and  skimmed  the  cream  off  the 
market. 

For  such  transactions  great  resources  are  in  any  event 
needed.  But  so  huge  are  the  amounts  involved  in  cor- 
porate borrowings  that  were  the  loan  contractors  depend- 
ent solely  upon  their  own  capital,  any  unforeseen  check 
in  the  sale  of  the  issue,  indeed,  the  inevitable  delay  in  its 
absorption,  would  result  in  congestion.  The  case  would 
be  exactly  parallel  with  that  of  a  merchant,  who,  having 
invested  his  own  limited  capital  in  desirable  wares,  would 


14 


Bank  Loans  and  Stock  Exchange  Speculation 

be  unable  to  make  further  purchases,  however  favorable 
be  the  terms  offered  or  certain  the  future  demand,  until 
customers  had  taken  off  his  hands  a  sufficient  amount  of 
those  things  with  which  he  was  already  stocked. 

The  existing  banking  organization  of  the  United  States 
meets  this  requirement  of  business  enterprise  with  mod- 
erate success.  Such  evils  as  from  time  to  time  disclose 
themselves  seem  inevitably  incident  to  the  alternating 
fever  and  quiescence  of  modern  economic  organization. 
In  flush  times,  when  promoters  abound  and  banks  become 
less  prudent,  the  availability  of  corporate  securities  as 
bank  collateral  undoubtedly  serves  as  an  artificial  stimu- 
lus to  evoke  projects  that  are  unnecessary  or  unwise. 
The  way  is  opened  for  a  perilous  process  of  pyramiding 
that  leads  swiftly  to  reckless  involvement, 

A  further  criticism  is  that  such  bank  loans  tend  to 
encroach  upon  the  accommodations  that  can  be  afforded 
ordinary  business  activity.  The  times  in  which  the  banks 
are  most  heavily  involved  in  syndicate  underwritings  are 
periods  of  business  activity  rather  than  quiet.  It  is  then 
that  corporate  projects  take  amplest  shape  and  flotation 
follows  quickly  upon  flotation.  During  the  upswing  the 
absorption  is  so  rapid,  the  profits  so  alluring,  and  the 
public  service  so  plausible  that  banking  conservatism  is 
put  to  the  test  merely  in  distinguishing  accommodation 
from  excess  and  enterprise  from  venture.  A  bank's 
mercantile  customers  ordinarily  have  the  first  claim  upon 
its  facilities.  But  in  periods  of  business  calm  not  all  of 
its  resources  will  be  so  employed  and — in  lieu  of  the  even 
less  profitable  avenue  of  employment  in  stock-exchange 
loans — advances  upon  syndicate  collateral  are  very  accept- 

15 


National     Monetary     Commission 

able.  Such  loans  are  nominally  payable  on  demand,  but 
in  reality  they  are  much  less  liquid  than  the  ordinary  call 
loan.  This  is  especially  the  case  with  interior  banks,  whose 
relation  to  the  debtor  broker  and  even  to  the  securities 
involved  is  likely  to  be  less  impersonal  than  of  a  New 
York  bank.  The  consequence  is  that  expanding  business 
requirements  may  encounter  less  preparedness  from  banks 
so  encumbered  than  would  otherwise  occur. 

These  are  unwelcome  contingencies  incident  to  modem 
business  daring,  from  which  no  form  of  banking  organiza- 
tion will  be  always  and  entirely  immune.  Greater  pub- 
licity and  closer  supervision  in  operation,  more  direct 
responsibility  and  more  certain  accountability  in  control, 
with,  perhaps,  some  legal  maximum  as  to  extent  of  par- 
ticipation, will  serve  as  local  correctives.  But  the  real 
cause  of  the  disorder  is  that  more  fundamental  defect  of 
the  American  banking  system — the  absence  of  an  open 
discount  market. 

As  long  as  our  banks  are  deprived  of  the  usual  and  proper 
investment  for  growing  reserves,  guaranteed  commercial 
paper  of  international  validity,  we  may  expect  to  suffer 
periodically  from  undue  and  even  imwise  banking  par- 
ticipation in  corporate  financiering. 

III. 

The  investment  of  a  considerable  proportion  of  loanable 
resources  in  stock-exchange  securities  is  an  almost  invaria- 
ble practice  of  American  banking  institutions.  On  Sep- 
tember I,  1 9 ID,  the  7,173  national  banks  in  the  United 
States  held  $854,127,665  in  "bonds,  securities,  etc.," 
being   in   the   main   State,   county,   municipal,   railroad, 

16 


Bank  Loans  and  Stock  Exchange  Speculation 

public  service,  and  other  bonds,  with  a  sprinkling  of  stocks 
(presumably  taken  for  debt) ,  warrants,  and  judgments, 
but  including  no  part  of  the  holdings  of  United  States  or 
other  bonds  to  secure  note  circulation  or  Federal  deposits. 

The  extent  of  such  investments  is  subject  to  seasonal 
fluctuation,  and,  even  more,  to  the  irregular  variation  of 
general  economic  and  financial  conditions.  Here  and 
there  particular  banks  have  abstained  from  such  invest- 
ments, and  in  some  cases  this  restraint  has  become  an 
avowed  policy.     But  the  ordinary  practice  is  as  described. 

The  motives  leading  to  such  investments  are  in  some 
cases  specific  and  obvious.  The  financial  institutions  off 
Baltimore  find  it  profitable  to  invest  largely  in  Baltimore 
City  bonds,  because  such  securities  are  not  only  exempt 
from  State  and  local  taxation  but,  by  a  curious  series  of 
implied  agreements,  administrative  rulings,  and  legal 
enactments,  carry  with  them  a  corresponding  tax- 
deducting  power,  to  the  extent  of  largely  relieving  some 
of  the  institutions  from  capital  taxation.  More  common 
is  a  bank's  investment  in  a  particular  State's  or  mimici- 
pality's  bonds  in  the  hope,  or  even  as  the  condition  of 
becoming  its  public  depositary  or  of  securing  some  public 
or  semipublic  account.  This  may  even  extend  to  a  private 
corporation,  whose  profitable  banking  account  can  be 
more  certainly  retained  by  participation  in  its  i>xancing. 
Finally,  some  part  of  a  bank's  securities  represent  the 
foreclosure  of  hypothecated  securities,  acquired  by  the 
institution  for  its  o\vn  ultimate  protection. 

But  these  instances  explain  only  a  fractional  part  of  the 
aggregate  holdings  and  do  not  touch  the  essential  con- 
sideration, which  is — that  a  bank  buys  securities  because 

17 


National    Monetary     Commission 

it  can  find  no  other  profitable  investment  during  recurring 
periods  when  business  is  quiescent  for  such  of  its  surplus 
funds  as  it  would  otherwise  employ  in  its  regular  channels. 

When  reserves  become  congested  and  the  local  demand 
for  money  is  exhausted,  neither  the  call  money  market 
in  New  York  nor  the  masked  rediscount  of  country  bank 
paper  nor  the  availability  through  brokerage  houses  of 
the  promissory  paper  of  a  limited  number  of  widely  known 
mercantile  and  industrial  establishments  will  absorb  the 
excess,  and  recourse  is  had  to  the  bond  market. 

From  whatever  point  of  view  regarded  this  apparent 
necessity  under  which  American  banks  now  labor  of  tying 
up  large  parts  of  their  loanable  funds  in  stock-exchange 
securities  is  unfortunate.  It  offers  an  unhealthy  stimulus 
to  corporate  financiering  by  supplying  a  temporary  and 
fictitious  market  for  investment  securities.  It  invites 
speculative  gains  and  losses  by  the  fluctuation  in  market 
price  in  the  interval  between  purchase  and  liquidation. 
It  curtails  mercantile  accommodation  by  the  bank's 
reluctance  to  liquidate  such  securities  in  a  declining  mar- 
ket, and  it  injects  an  additional  element  of  risk  into 
banking  stability  in  the  temptation  to  invest  in  less 
seasoned  and  more  productive  bonds. 

In  making  such  investments  under  existing  conditions 
the  banks,  however,  obey  a  perfectly  sound  economic  im- 
pulse. Idle  funds  are  as  unhealthy  for  the  community  as 
they  are  unprofitable  to  the  banks.  It  is  probably  better 
in  the  long  run  that  investment  be  made  in  securities, 
with  all  attendant  uncertainties,  than  that  unemployed 
funds  accumulate  as  swollen  reserves  or  be  applied  to 
questionable  credits.     But  such  a  necessary  alternative  is 

i8 


Bank  Loans  and  Stock  Exchange  Speculation 

lamentable,  and  one  with  which  the  banking  institutions 
of  no  other  industrial  country  of  the  world  are  confronted. 
Everywhere  else  the  banking  surplus  of  one  community 
relieves  the  credit  strain  of  another,  and  in  so  doing  finds 
safe  and  convenient  investment  for  itself.  Here  again 
we  have  the  prime  defect  of  our  banking  system — the 
two-faced  evil  of  localized  commercial  paper — driving  the 
banks  on  the  one  hand  to  inconvenient  and  uncertain  in- 
vestment of  unemployed  funds,  and  lessening,  by  wasteful 
isolation  of  reserve,  the  maximum  banking  accommoda- 
tion which  the  mercantile  interest  of  the  country  might 
enjoy.  Finally,  it  is  questionable  whether  the  practice  of 
investing  in  securities  ordinarily  results  in  profit  to  the 
banks.  A  not  uncommon  experience  is  for  bonds  to  be 
bought  at  the  higher  level  incident  to  an  easy  money  mar- 
ket and  to  be  disposed  of  when  there  is  competitive  selling 
and  prices  have  weakened.  Even  when  a  profit  might 
have  been  realized,  bonds  so  bought  are  likely  to  be  held 
until  a  loss  is  shown,  then  to  be  carried  over  and  written 
off,  and  finally  to  be  sold  at  original  cost  when  the  next 
easy  money  period  begins. 

IV. 

The  modern  stockbroker  is  engaged  in  two  kinds  of 
activity — the  purchase  and  sale  of  investment  securities, 
and  the  conduct  of  speculative  operations  for  principals  or 
in  personal  behalf.  Ordinarily  both  classes  of  business 
are  conducted  by  the  same  house,  but  there  are  many 
bond  houses  who  do  not  invite  speculative  accounts  and, 
on  the  other  hand,  many  commission  houses  figure  inap- 
preciably in  the  investment  market. 

19 


National     Monetary     Commission 

In  connection  with  each  class  of  business  large  banking 
accommodations  are  involved.  Such  bank  advances  take 
the  form  either  of  time  or  of  call  loans,  according  to  the 
prudence  of  the  broker,  the  state  of  the  money  market, 
and  the  disposition  of  the  lending  banks.  The  purpose  of 
a  sagacious  broker,  as  of  a  cautious  merchant,  is  to  make 
sure  of  having  at  all  times  that  amoiuit,  and  no  more,  of 
borrowed  capital  that  he  requires,  and  to  pay  for  it  the 
lowest  price  for  which  it  can  be  obtained  at  any  time  during 
the  period  of  its  use.  This  end  can  never  be  completely 
attained.  If  money  be  cheap  and  the  prospect  for  any 
stringency  unlikely,  there  is  yet  reluctance  to  rely  entirely 
on  demand  loans  because  of  the  ever-present  possibility 
of  an  abrupt  change  in  the  general  financial  situation, 
certain  to  send  the  call  rate  bounding,  and  to  make  fur- 
ther or  even  continued  advances  impossible.  On  the 
other  hand,  time  money  ordinarily  commands  higher  rates 
than  call  money,  and  borrowers  are  unwilHng  in  periods  of 
easy  credit  to  tie  themselves  up,  so  as  to  be  unable  to 
profit  in  the  even  easier  money  market  likely  to  prevail  in 
the  future,  by  call  loans  and  by  the  sale  of  securities. 
When  the  situation  is  reversed  and  the  money  market 
restricted,  there  is  nevertheless  the  same  reluctance  to 
use  call  money  exclusively,  for  conditions  may  easily  be- 
come prohibitive;  while,  on  the  contrary,  the  exclusive 
use  of  time  money,  even  were  it  practicable,  is  checked 
by  the  hope  of  improving  markets  and  lower  rates. 

One  striking  feature  of  such  loans,  whether  time  or 
demand,  is  to  be  noted.  The  merchant  or  manufacturer 
is  able  to  secure  banking  accommodations  up  to  a  certain 
point  upon  his  own  personal  credit — that  is,  by  the  dis- 


Bank  Loans  and  Stock  Exchange  Speculation 

counting  of  his  own  promissory  note  or  single-name  paper, 
unsecured  by  pledge  of  collateral.  Such  is  never  the  case 
with  the  bond  dealer  or  stockbroker.  However  ample  his 
resources  or  unquestioned  his  credit,  the  broker  can  only 
obtain  loans  upon  collateral  securities.  Any  attempt  to 
secure  credit  on  other  terms  is  a  confession  of  financial 
weakness  and  is  never  resorted  to  save  in  straits.  The 
explanation  of  this  seeming  anomaly  appears  to  lie  partly 
in  the  greater  amounts,  relative  to  resources,  involved  in 
brokers'  transactions  as  compared  with  mercantile  business, 
but  even  more  in  the  fact  that  the  wares  of  the  merchant 
and  the  unfinished  products  of  the  manufacturer,  which 
serve  as  the  ultimate  basis  of  mercantile  loans,  are  either 
immobile  or  inchoate,  whereas  the  securities  which  rep- 
resent the  stock  in  trade  of  the  broker  are  capable  of  easy 
and  convenient  removal  and  possess  immediate  marketable 
value,  thus  readily  lending  themselves  to  the  cautious 
impulse  of  the  banker  to  protect  his  advances.  Even  in 
those  branches  of  mercantile  activity  where  the  stock  in 
trade  is  capable  of  reduction  to  marketable  and  movable 
form  by  warehouse  storage — cotton,  grain,  canned  goods — 
bank  advances  are  ordinarily  limited  to  collateral-secured 
loans. 

In  so  far  as  the  activities  of  the  stockbroker  relate  to  the 
purchase  and  outright  sale  of  investment  securities,  he  is 
a  dealer  in  merchandise.  He  buys  securities  of  such  kinds 
as  will  appeal  to  the  varying  desires  of  his  customers, 
at  prices  which  will  permit  sale  at  usual  business  profits. 
Accordingly,  his  vaults,  like  the  shelves  of  the  merchant 
or  the  warehouse  of  the  manufacturer,  are  at  all  times 
stocked  with  investment  wares  awaiting  the  demands  of 
his  investing  clientele. 


National     Monetary     Commission 

It  is  true  that  a  considerable  part  of  the  stockbroker's 
wares  will  consist  of  undistributed  syndicate  holdings  or 
unabsorbed  underwriting  participation,  upon  which  credit 
advances  have  been  made  in  the  manner  already  discussed 
in  a  preceding  section.  But  over  and  above  such  holdings 
the  ordinary  bond  house  is  the  owner,  by  actual  purchase 
and  payment,  of  blocks  of  securities  acquired  for  purposes 
of  sale  at  profit,  and  the  actual  distribution  of  which  is 
pressed  with  all  the  energy  and  skill  of  commercial  vending. 

Advances  of  credit  upon  the  unsold  part  of  this  stock 
in  trade  are  sought  from  the  banks  in  supplement  of 
the  broker's  own  working  capital.  The  relation  of  the 
stockbroker  to  the  banks  is,  in  this  particular,  like  that 
of  any  other  business  man.  He  conducts  a  certain  kind 
of  business  and  has  a  certain  amount  of  capital  of  his 
own  with  which  to  conduct  it.  Restricted  within  these 
limits,  not  only  will  his  operations  be  meager  and  un- 
profitable, but  the  facilities  which  he  can  offer  the  invest- 
ing public  in  variety  and  readiness  of  investment  securities 
and  the  advantage  which  corporate  seekers  of  capital 
can  obtain  from  such  middlemen,  will  be  correspondingly 
curtailed.  *To  press  the  analogy,  such  restriction  would 
find  exact  parallel  in  the  case  of  a  merchant  denied  credit 
upon  unsold  wares  or  a  manufacturer  upon  undistributed 
produce. 

This  service  is  rendered  with  reasonable  adequacy  by 
our  present  banking  system.  Bond  houses  suffer  some- 
thing, in  common  with  all  mercantile  enterprise  from  the 
inelasticity  of  bank  credits  in  periods  of  economic  expan- 
sion, but  the  treatment  accorded  is  often  preferential 
and  the  discomfort  on  the  whole  less  acute. 


Bank  Loans  and  Stock  Exchange  Speculation 

V. 

There  has  been  much  controversy  as  to  the  function  of 
speculation  in  modern  economic  Hfe.  Those  directly  en- 
gaged therein  have  insisted  upon  its  respectability  and 
dignity  as  a  form  of  business  enterprise.  Radical  attack 
has  denounced  speculation  as  a  parasitic  activity,  the 
effect  of  which  is  legalized  plunder  and  demoralization  of 
wholesome  business  method.  The  consensus  of  qualified 
opinion  is,  however,  that  this  latter  sweeping  condemna- 
tion can  be  applied,  if  at  all,  only  to  the  extravagant 
excesses  of  speculative  fever  and  that  the  intelligent  dis- 
counting of  economic  developments — the  essence  of 
speculation — serves  as  a  balance  wheel  of  industrial  life. 

Such  a  discussion,  however,  smacks  of  the  academic. 
Whatever  drastic  measures  may  be  taken  to  eliminate 
speculative  abuses,  it  is  reasonably  certain  that  large  play 
will  still  be  left  for  those  adventurous  spirits  who,  by  for- 
sight,  daring,  or  blind  hazard,  seek  to  gauge  the  course  of 
coming  events  and  who  reap  profits  or  suffer  losses  ac- 
cording to  the  accuracy  of  their  forecast  or  the  accident 
of  their  guess. 

During  the  calendar  year  ending  December  31,  1910, 
there  were  bought  and  sold  on  the  New  York  Stock 
Exchange  164,051,061  shares  of  stock  of  an  approximate 
value  of  $14,124,875,879.  Dealings  on  the  stock  ex- 
changes of  Boston,  Philadelphia,  Chicago,  and  Baltimore, 
aggregated  21,179,574  shares.  Allowing  for  trading  in 
other  cities  and  in  the  outside  markets  of  New  York, 
it  is  probably  a  conserv^ative  estimate  to  place  the  total 
number  of  shares  dealt  in  the  United  States  at  225,000,000 
of  an  approximate  value  of  $20,000,000,000. 

23 


National    Monetary     Commission 

A  substantial  proportion  of  this  trading  consists  of 
outright  purchases  for  investment  purposes  by  corpora- 
tions, institutions,  trustees,  and  individuals.  But  the 
overwhelming  part  of  it,  as  well  as  an  appreciable  amount 
of  trading  in  active  bonds,  represents  speculative  com- 
mitments for  the  rise  or  fall  by  stockbrokers  acting  as 
agents  or  trading  for  themselves. 

Such  operations  are  financed  in  the  main  by  bank 
advances.  The  ordinary  procedure  is  for  the  operator 
to  supply  20  per  cent  of  the  purchase  price — or  if  acting 
through  a  broker  10  per  cent  and  the  broker  another 
10 — and  the  banks  to  advance  the  remaining  80  per 
cent  on  a  demand  loan  upon  a  pledge  of  the  securities 
purchased,  or  their  equivalent,  as  collateral.  The  quota 
advanced  by  the  broker  will  be  drawn  from  existing 
bank  deposits  created  largely  by  time  loans  negotiated 
to  guard  against  possible  market  stringency,  but  likewise 
secured  by  collateral. 

The  ready  availability  of  banking  funds  for  such 
speculative  operations  is,  as  has  so  often  been  pointed 
out,  the  direct  consequence  of  unwholesome  elements 
in  the  banking  system  of  the  United  States.  Under  the 
provisions  of  the  national-bank  act  interior  banks  are 
permitted  to  deposit  three-fifths  of  their  legal  (15  per 
cent)  reserves  with  correspondents  in  reserve  and  central 
reserve  cities,  and  reserve  city  banks  in  turn,  up  to  the 
extent  of  one-half  of  their  legal  (25  per  cent)  reserves, 
may  count  their  deposits  with  central  reserve  banks  as  a 
part  of  such  reserves. 

The  original  motive  of  such  provision  was  probably 
the  greater  and   more   regular   mercantile   requirements 


24 


Bank  Loans  and  Stock  Exchange  Speculation 

of  the  central  reserve  cities,  notably  New  York,  in  con- 
trast with  the  seasonal  fluctuations  of  banking  needs 
in  the  interior  cities. 

To  insure  such  remittance,  the  New  York  banks  are  in 
the  habit  of  allowing  2  per  cent  interest  upon  country 
bank  deposits  subject  to  call.  The  consequence  is  that 
the  interior  banks,  failing  any  other  avenue  of  profitable 
short-time  employment,  remit  to  New  York  not  only  the 
authorized  quota  of  their  reserves,  but  also  the  surplus 
funds  which  accumulate  with  recurring  business  inactivity. 

It  is  not  possible  for  the  New  York  banks  to  employ 
all  of  such  deposits  in  mercantile  loans  and  discounts, 
even  were  it  sound  banking  to  lend  call  money  on  time 
loans.  The  only  method  of  profitable  use  is  demand 
loans,  and  the  only  large  market  is  offered  by  speculative 
operators  on  the  stock  and  produce  exchanges. 

We  have  here  all  the  conditions  favorable  to  artificial 
stimulation  of  stock  exchange  speculation.  At  periods 
of  seasonal  dullness,  and,  even  more,  at  times  of  business 
reaction,  the  irresistible  lure  of  payment  for  idle  money 
attracts  the  surplus  funds  of  the  interior  banks  to  New 
York,  there  to  be  pressed  upon  the  call  money  market  for 
what  it  will  bring,  and,  finding  regular  employment  only 
in  stock  exchange  operations,  to  encourage  speculative 
commitments  at  the  very  time  when  quiescence  is  in 
order.  As  there  is  unwholesome  stimulation,  so  there  is 
sudden  and  wasteful  liquidation.  When  reviving  busi- 
ness leads  the  interior  banks  to  reduce  their  New  York 
balances,  the  depositary  banks  meet  the  strain  by  calling 
loans,  with  the  result  that  the  speculative  movement  for 
the  rise  is  reversed  and  a  repressive  influence  cast  upon 
general  business. 

25 


National    Monetary     Commission 

The  primary  cause  of  this  unwholesome  sequence  is 
obviously  again  the  inability  of  the  interior  banks  to  find 
profitable  employment  for  idle  funds  during  recurring 
periods  of  business  calm.  A  part  of  the  capital  so  dis- 
engaged is  put,  by  the  stronger  or  bolder  banks,  as  has 
been  noted,  into  stock  exchange  securities;  but  that  more 
considerable  part,  likely  to  be  required  upon  earlier  or 
more  abrupt  occasion,  and  all  balances  of  many  banks 
reluctant  to  tie  up  any  part  of  their  resources  in  semi- 
speculative  investment,  flow  irresistibly  to  New  York 
depositaries. 

It  is  certain  that  a  measure  of  stock  speculation  would 
persist,  even  if  the  resources  of  the  New  York  banks  were 
alone  available  for  financing  it,  but  the  extent  of  such 
accommodation,  even  when  supplemented  by  the  demand 
loans  made  available  by  individual  capitalists,  would  be 
limited  and  the  cost  of  securing  it  would  be  greater. 
Individual  speculation  would  be  less  in  amount  and  nar- 
rower in  distribution.  Most  of  all,  the  periods  of  specu- 
lation, in  so  far  as  determined  by  the  cheapness  of  money, 
would  vary  logically  with  the  movement  of  general  busi- 
ness, instead  of,  as  at  present,  running  in  vicious  oppo- 
sition thereto. 
/p^Any  reform  in  our  banking  system  which  will  create 
a  logical  form  of  investment  for  temporarily  idle  banking 
resources  may  therefore  be  expected  to  discom^age  instead 
of  to  promote  speculative  excesses.  The  banking  ex- 
perience of  every  other  industrial  country  of  the  world 
shows  that  guaranteed  bills  of  short  maturity  constitute 
|/  such  proper  investment.  Over  and  above  all  other  advan- 
tages which  would  attend  the  acceptance  of  commercial 

26 


Bank  Loans  and  Stock  Exchange  Speculation 

paper,  whether  by  a  new  central  banking  agency  or  by 
powerful  existing  institutions,  there  would  surely  follow 
through  the  diversion  of  periodically  accumulating  bank- 
ing funds  into  this  more  healthful  channel  a  marked 
arrest  of  the  wild  course  of  American  speculation. 


97 

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